How to Avoid Whipsaws

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In trading terminology, having experienced a whipsaw means that both your initial entry order and your stop loss order were executed in the same trading session, thereby resulting in a realized trading loss.

Whipsaws can be devastating to a Trader operating in the forex market using a leveraged margin account with a limited amount of fund available to speculate with. A good forex strategy should therefore include a plan on how to avoid whipsaws when trading currencies.

The following sections give some additional information about whipsaws and some sound forex trading tips to help you avoid them.

When Whipsaws Tend to Occur

The first thing to know about whipsaws, is that this troublesome situation seems especially prone to occurring in the forex market during the choppy, volatile trading conditions characteristic of low liquidity trading environments surrounding the release of key economic data.

Other situations that can cause whipsaws include the announcement of key news events, such as natural disasters and wars. Political destabilizing events like elections, scandals, resignations or assassinations can also result in whipsaws, as can the execution of very large market orders.

Three Tips for Avoiding Whipsaws

Most traders should seek to avoid whipsaws whenever possible, due to the implied loss involved, although it should be noted that taking a small loss may turn out to be better forex strategy in the long run than allowing the loss to increase to a much greater and devastating degree.

Nevertheless, some common sense tips to help you avoid whipsaws include the following:

Tip #1: Focus on the Trend and Momentum

Many technical traders can avoid whipsaws by first reviewing their forex charts closely over several different time frames to identify the prevailing short, medium and long term trends before establishing a position or placing an order. They should generally seek to establish positions in the direction of the appropriate trend to help them avoid being whipsawed by corrective exchange rate movements.

Also, keeping a close eye on important momentum indicators like the Relative Strength Index or RSI can help a trader identify oversold and overbought market conditions that are ripe for a correction.

Using major chart points to trade off — rather than less significant support and resistance levels — can also help reduce the risk of whipsaws.

Tip#2: Watch Your Own Stops

Large players and market makers tend to push vulnerable markets around in the hopes of triggering a group of stops, especially in illiquid trading conditions, and the forex market is no exception.

You can often avoid having your stops triggered by a transient market move by watching your stop loss orders yourself, rather than by placing them with your broker.

Nevertheless, traders need to develop a good degree of discipline when it comes to taking losses to avoid having their losses become too large for comfort.

Tip#3: Avoid Volatile and Illiquid Trading Conditions

Since whipsaws tend to happen in volatile and illiquid markets, traders can try to anticipate when at least some of these situations might occur.

Many forex traders avoid whipsaws by squaring positions around the release of a major economic number or once a major news story is released that could boost volatility as it develops.

An example of such a number that can cause volatile trading conditions is the U.S. Non-Farm Payrolls data typically released on the first Friday of each month at 8:30am New York time.